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Persistent gaps and default traps

Luis Catão (), Ana Fostel and Sandeep Kapur

Journal of Development Economics, 2009, vol. 89, issue 2, 271-284

Abstract: We show how vicious circles in countries' credit histories arise in a model where output persistence is coupled with asymmetric information about output shocks. In such an environment, default signals the borrower's vulnerability to adverse shocks and creates a pessimistic growth outlook. This translates into higher interest spreads and debt servicing costs relative to income, raising the cost of future repayments, thereby creating "default traps". We build a long and broad cross-country dataset to show the existence of a history-dependent "default premium" and of significant effects of output persistence on sovereign creditworthiness, consistent with the model's predictions.

Keywords: Sovereign; Debt; Serial; default; Default; premium; Emerging; market; bond; spreads; Asymmetric; information; Output; persistence (search for similar items in EconPapers)
Date: 2009
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